Saturday, January 30, 2016

The
international oil prices have continued to tumble for many months now and we
are currently looking at crude oil being available at around $30 per barrel. In
spite of this, the price of petrol and diesel in India hasn’t come down by
much. The purpose of this article is to review the situation and understand the
economics behind how oil is priced in India.

Why this
article: Social media is ripe with posts about how the central government is
cheating us by pricing petrol and diesel so high when oil price is so low. Unfortunately
most posts ignore many basic facts and just consider the crude oil price in the
market. Even though the price of Petrol has returned to around 60 rupees from
its all-time high of around 75 rupees, people are still wondering if its really
worth that much. So, I thought it would be a good idea to share the requisite
details.

How Fuel is
Priced in India

There are four
main components in the price of Fuel in our country. They are:

How
much it costs to Procure & refine Crude Oil to Generate Petrol or Diesel

Excise
Duty charged by Central Government

VAT
Taxes charged by State Governments

Commission
to Fuel Pump Operators

How Much it
Costs to Procure & Refine Crude Oil to Generate Petrol or Diesel

Explaining
how much it costs to refine Crude Oil to produce Petrol or Diesel is a
sensitive subject better left to experts in the Oil Industry. This is the
variable part in the equation – whenever the international oil prices change,
the amount of money required to produce petrol or diesel in our country is
going to vary. So, am going to skip that part.

Of course,
we also need to consider the cost of transporting the crude oil to the refinery
and the refined product to the fuel stations which would also get added into
the cost of fuel. This shipping could account easily for about 5% of the cost
of the fuel we buy.

Central
Government Excise Duty on Petrol & Diesel

The Central
Government charges an Excise Duty on Petrol and Diesel that is sold to the
market. So, for every litre of fuel you buy, you are actually paying this
excise duty to our government. Ever wondered what this amount is?

As of
January 2016, the Excise Duty is:

Petrol:
Rs. 20.48 Per Litre

Diesel:
Rs. 15.83 Per Litre

That’s a
lot of money isn’t it?

Just to
give you more information, the Excise Duty has been hiked multiple times in the
last 2-3 years. The Excise Duty on Petrol was around Rs. 10 per litre in 2014
and has almost doubled in the past 2 years. Similarly, the Excise Duty on
Diesel was around Rs. 4 per litre in 2014 and has almost quadrupled in the past
2 years mainly because the government feels the low diesel price has resulted
in many folks opting for fuel guzzling SUV’s and personal vehicles instead of
Petrol. The main reason for lower excise duty on diesel was because diesel was
used in Agriculture and the government wanted to help farmers.

State
Government VAT on Gross Price of Petrol and Diesel

The State
Government charges a Value Added Tax on the Gross Price of Petrol & Diesel
(Refinery Price + Excise Duty) to generate revenue for its exchequer. This %
actually varies state to state which is the reason why the price of 1 litre of
fuel is different in different parts of our country. Take a look at the table
below:

As you can
see some states charge a higher VAT while the others a little lower. In most
cases the VAT is charged at around 20-30% of the gross price of fuel. This
amount ranges between Rs. 10-15 per litre for Petrol and Rs. 7-10 per litre for
Diesel (approximately)

The reason
I mention the amount here is to highlight the fact that both State and Central
Governments are collectively responsible for the high petrol prices in our
country.

As you can
see, the taxes we pay to the state and central governments is around 50% of the
cost at which fuel is being sold in our country. Even though the price per
barrel goes down, these taxes are pretty high which is one of the reasons for
the high prices. If our State/Central Governments wanted, we could actually get
fuel at much lower prices.

Commission
to Pump Operators

Of course,
the people who operate the Petrol Pumps need to make a living and pay for their
staff who fill-up petrol or diesel in our vehicles when we visit them – right?
On average the pump operators make around Rs. 1.5 to 2.5 per litre of fuel they
sell.

So, all
things staying As-Is, when the international oil prices Go Down, Petrol and
Diesel prices should Go Down – Right?

Unfortunately
No. We have missed considering an important piece of the Equation that is going
to impact the price of petrol and diesel. Do you want to venture a Guess?

As you can
see, 1 USD was ranging at around 40 rupees in 2006 but we are beyond 65 rupees
per dollar now. The Indian rupee has lost more than 50% of its value in the
past 10 years.

How
Exchange Rate Affects Oil Price

India pays
in USD for oil but our home currency is the Rupee. So, if our rupee is weak,
for the same amount in USD, we pay more in Indian Rupee – correct?

Look at the
table below for stats for the past 5 years:

Oil Price
per Barrel was $96 in Jan 2011 and we paid Rs. 4320 per barrel. In Dec 2015,
even though oil price came down by 60% and was at $37 per barrel, we are still
paying Rs. 2479 which is only a 40% reduction in rupee terms. So, just because
the price per barrel in USD is coming down it doesn’t mean oil price is going
to fall because our rupee has been falling consistently every year in the past
5 years.

Some Last
Words:

Revenue
generated by sale of fuels is one of the biggest sources of income for our
state and central governments. With a falling rupee, though oil prices have dropped, the amount in rupee hasnt dropped that much. However, both state and central governments have hiked their share of taxes to generate additional revenue for themselves which is why we havent been able to reap the full benefit of the crude oil price drops.

Note: India buys around 40% of its oil imports from Iran and pays in Rupees per barrel however still more than 60% of our oil is still imported in USD. Hence the comparison using INR & USD.

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